CHAPTER 3 CASE C-1
CHAPTER 3
RATIOS AND FINANCIAL PLANNING AT
EAST COAST YACHTS
1. The calculations for the ratios listed are:
Quick ratio = ($15,823,700 – 6,627,300) / $21,320,300
Quick ratio = .43 times
Inventory turnover = $148,600,000 / $6,627,300
Inventory turnover = 22.42 times
Total debt ratio = ($117,304,900 – 59,584,600) / $117,304,900
Total debt ratio = .49 times
Equity multiplier = $117,304,900 / $59,584,600
Equity multiplier = 1.97 times
Profit margin = $15,862,800 / $210,900,000
Profit margin = .0752, or 7.52%
2. Regarding the liquidity ratios, East Coast Yachts current ratio is below the median industry ratio.
This implies the company has less liquidity than the industry in general. However, the current ratio
is above the lower quartile, so there are companies in the industry with lower liquidity than East
CHAPTER 3 CASE C-2
The turnover ratios are all higher than the industry median; in fact, all three turnover ratios are
The financial leverage ratios are all below the industry median, but above the lower quartile. East
The profit margin for the company is about the same as the industry median, the ROA is slightly
Overall, East Coast Yachts’ performance seems good, although the liquidity ratios indicate that a
Below is a list of possible reasons it may be good or bad that each ratio is higher or lower than the
Ratio Good Bad
Current ratio Better at managing current
accounts.
May be having liquidity problems.
Quick ratio Better at managing current
May be having liquidity problems.
strict. Decreasing receivables
turnover may increase sales.
Total debt ratio Less debt than industry median
means the company is less likely
to experience credit problems.
Increasing the amount of debt can
increase shareholder returns.
Especially notice that it will
increase ROE.
increase ROE.
Interest coverage Less debt than industry median
means the company is less likely
to experience credit problems.
Increasing the amount of debt can
increase shareholder returns.
Especially notice that it will
increase ROE.
Profit margin The PM is slightly above the May be able to better control
CHAPTER 3 CASE C-3
industry median, so it is
performing better than many
peers.
costs.
If you created an Inventory / Current liabilities ratio, East Coast Yachts would have a ratio that is
lower than the industry median. The current ratio is below the industry median, while the quick
3. To calculate the internal growth rate, we first need to find the ROE and the retention ratio, so:
ROE = Net income / Total equity
b = Addition to RE / Net income
So, the sustainable growth rate is:
Sustainable growth rate = (ROE × b) / [1 – (ROE × b)]
The sustainable growth rate is the growth rate the company can achieve with no external financing
At the sustainable growth rate, the pro forma statements next year will be:
Income statement
Sales $259,201,872
COGS 182,633,467
Other expenses 30,961,657
CHAPTER 3 CASE C-4
Balance sheet
Assets Liabilities & Equity
Current Assets Current Liabilities
Cash $4,038,092 Accounts Payable $8,575,784
Accounts rec. 7,264,535 Notes Payable 17,627,448
So, the EFN is:
EFN = Total assets – Total liabilities and equity
The ratios with these pro forma statements are:
Current ratio = $19,447,760 / $26,203,232
Current ratio = .74 times
Total asset turnover = $259,201,872 / $144,170,933
Total asset turnover = 1.80 times
Total debt ratio = ($144,170,933 – 74,257,425) / $144,170,933
Total debt ratio = .48 times
Debt–equity ratio = ($26,203,232 + 36,400,000) / $74,257,425
CHAPTER 3 CASE C-5
Debt–equity ratio = .84 times
Equity multiplier = $144,170,933 / $74,257,425
Equity multiplier = 1.94 times
The only ratios that changed are the debt ratio, the interest coverage ratio, profit margin, return on
assets, and return on equity. The debt ratio changes because long-term debt is assumed to remain
4. Pro forma financial statements for next year at a 20 percent growth rate are:
Income statement
Sales $253,080,000
COGS 178,320,000
Other expenses 30,230,400
Depreciation 6,879,000
Balance sheet
Assets Liabilities & Equity
Current Assets Current Liabilities
Cash $3,942,720 Accounts Payable $8,373,240
Accounts rec. 7,092,960 Notes Payable 17,211,120
CHAPTER 3 CASE C-6
Shareholder Equity
Common stock $5,580,000
So, the EFN is:
EFN = Total assets – Total liabilities and equity
5. Now we are assuming the company can only build in amounts of $25 million. We will assume that
the company will go ahead with the fixed asset acquisition. In this case, the pro forma financial
statement calculation will change slightly. To estimate the new depreciation charge, we will find the
current depreciation as a percentage of fixed assets, then apply this percentage to the new fixed
assets. The depreciation as a percentage of assets this year was:
The new level of fixed assets with the $25 million purchase will be:
So, the pro forma depreciation as a percentage of sales will be:
We will use this amount in the pro forma income statement. So, the pro forma income statement will
be:
Income statement
Sales $253,080,000
COGS 178,320,000
Other expenses 30,230,400
Depreciation 8,573,649
CHAPTER 3 CASE C-7
The pro forma balance sheet will remain the same except for the fixed asset and equity accounts. The
fixed asset account will increase by $25 million, rather than the growth rate of sales.
Balance sheet
Assets Liabilities & Equity
Current Assets Current Liabilities
Cash $3,942,720 Accounts Payable $8,373,240
Shareholder Equity
Common stock $5,580,000
Fixed assets Retained earnings 67,513,319
So, the EFN is:
EFN = Total assets – Total liabilities and equity